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The stock market sold off last week, and gold took a big hit, its price falling nearly 10% on Monday, April 15. Meanwhile, the 10-year Treasury bond continues to have a paltry yield, most recently about 1.7%. For some perspective on all this, Barron's turned to Scott Minerd, the chief investment officer of Guggenheim Partners. Overseeing about $170 billion for its clients, Guggenheim has raised its profile recently as a deal maker. It was the main player in the purchase of the Los Angeles Dodgers last year for $2.15 billion, a massive sum for a sports team.

Minerd's expertise isn't baseball. Rather, he cut his teeth as a bond trader in the 1980s, and rose to prominent positions at Morgan Stanley and Credit Suisse. The 54-year-old money manager blends a keen knowledge of financial history with a good understanding of financial markets' daily workings, and the combination has paid off. Since its inception in January 1999 through late February of this year, Guggenheim's core fixed-income composite, a proxy for underlying performance, has an annual return of 7.3%, versus 5.69% for the Barclays U.S. Aggregate Index. Minerd spoke with us from his office in Santa Monica, Calif., by telephone last week.

"We are at the brink of a fairly healthy correction in equities, probably in the neighborhood of 10% and maybe more." — Scott Minerd
Manuello Paganelli for Barron's

Barron's:What are your thoughts about the recent selloffs, gold's in particular?

Minerd: Those recent events were dominated by a gold-market crash. The pricing behavior is consistent with a crash, and crashes are fairly rare. They happen maybe every five to 10 years. I've been through a number of them. There was the bond-market crash in '94. There was the stock- market crash in 1987. And there was the gold- market crash back in 1980. So the crash in gold this time is a bit like a canary in a coal mine. Basically, the liquidity came out of the gold market, the bad noise and selling pressure were met with very little buying interest, and this caused a complete collapse in prices. The interesting thing about the gold move [on April 15] was that as the day went on, it became fairly predictable that other assets were going to have to be sold to meet margin calls. So that put downward pressure on equities, as people sought to raise the cash to meet their margin calls. But underneath the surface, you have to ask: "What's going on here in the short run?" And in the short run, we are starting to see a lot of negative divergences in the market. Specifically, we've had the transports break down recently, and the transports, of course, are leading indicators for the broader market.

What's that telling you?

I don't believe that we are anywhere near having a recession or a severe economic slowdown. But the transports are saying that market expectations, whether for stocks, gold, or other assets, have gotten ahead of the fundamentals. And the disappointment that we've had over the past two weeks in terms of economic data -- and the disappointment that we've had with the collapse in gold prices -- is starting to feed into the broader market. We are at the brink of a fairly healthy correction in equities, probably in the neighborhood of 10% and maybe more. But it really only reflects that the economic fundamentals aren't in sync with what the market had expected.

Which fundamentals are you talking about?

We could go through a whole laundry list of fundamentals. In the U.S., we are not seeing the growth in retail spending that we were expecting. In Europe, the economic downturn has been more protracted, and it's probably getting worse than anybody expected.

Yes. The interesting thing about gold is that it isn't uncommon in generational bull markets to have the type of correction that we had last week. Over the past few months, gold has gone from $1,700 [a troy ounce] down to around $1,350. The question is: Is this the end of the bull market or just a major correction in a long-term secular bull market? You could take gold down to $1,100, and the bull market would still be intact. We've done a lot of work over the past couple of days on market crashes, and there seem to be two scenarios. In one, the crash represents the beginning of a reversal in the long-term trend. In the other, it is a sharp correction in a long-term bull market. The crash of 1929 was an example of the beginning of a change in a long-term trend; it took 27 years to reverse itself. However, the crash of 1987 reversed itself in two years.

So what's the outlook for gold?

The fundamentals underneath gold are as strong as they were at any time in the past five years, especially given the underlying thesis that printing paper money is likely to go on for a long time, possibly through 2019.

Presumably, low rates are a boost to stocks.

Yes, they are. Despite my near-term pessimism, I expect that within three years, we will be 30% to 35% higher on the Standard & Poor's 500 than we are today. I see things like the continued discovery of new gas reserves, the move toward energy independence, and even demographics working in favor of the U.S. The working-age population in the U.S. will continue to increase for the next 30 years, while in virtually every other major industrial society, whether it be Japan, Europe, or China, the demographics of the working-age population turn negative. So the U.S. has a lot of fundamental tail winds behind it, and I believe we are in the early stages of an age of prosperity that will last probably somewhere between 10 to 15 years.

What about interest rates and Federal Reserve policy?

Fed Chairman Ben Bernanke has proven that he will err on the side of providing too much liquidity, rather than too little. The Fed fundamentally believes that deflation is more difficult to fix than inflation. So, if there is going to be a policy error, it is going to occur by creating too much inflation. Having said that, I've been taking a hard look at the output gap—the difference between potential GDP [gross domestic product] and actual GDP -- and the natural rate of unemployment [also known as full employment]. Historically, the Fed doesn't begin tightening until unemployment falls below its natural rate. The rate at which we are seeing improvement in jobs -- which, by the way, is actually not bad -- is pretty consistent with the prior expansion's. It's just that the hole is so deep.

We don't see the Fed beginning to think about raising rates until maybe 2017 and possibly as late as 2019. That lines up very well with a timetable for Janet Yellen, vice chairman of the Federal Reserve's board of governors, to take over for Bernanke. She has a history of seeing accommodative policy as being useful in terms of economic output and, given the downward pressure that we are going to see on prices as a result of commodity declines and other things, that it is creating a window of opportunity in which the Fed can feel comfortable delaying rate increases, perhaps late into the decade.

You recently laid out the case for giving the Barclays U.S. Aggregate Index a wide berth. Why?

The Lehman Aggregate, or Agg, was developed to be fairly reflective of what the bond markets look like. But as the recent financial crisis developed and the market's composition changed, there was this bigger and bigger presence of U.S. Treasury securities and agency securities in the index, which they now dominate. But that doesn't really reflect what investors are necessarily looking for in a fixed-income portfolio. So managers who have spent most of their careers trying to mimic or track the Lehman Agg are starting to give up lots of excess return, relative to what is available in other sectors of the market. They are overweight in Treasury securities and agency holdings. But even with spreads as tight as they are, there's still a big gap between Treasuries and things like corporate bonds and asset-backed securities. A 10-year Treasury yields about 1.7%, but you can buy corporates or asset-backed securities that yield north of 4%. So you are giving up more than 50% of your total possible return by investing in a portfolio that is heavily weighted to the Barclays Agg. And, of course, if you stray from the Barclays Agg, you have to accept that there is going to be more tracking error versus the index, but there is more upside in corporate bonds and asset-backed securities. Institutional investors, like pension funds, that have been used to evaluating managers based on how well they track the Barclays Agg are sacrificing a lot of return. And in this world, return is everything.

So, what should investors pay attention to?

The biggest thing is the fact that fiscal policy around the world is being hampered by austerity. Whether it is in Europe, the U.S., or even Japan, there are limits to deficit spending. And so the central bank is the primary provider for every solution related to economic activity. That means that if they are going to do anything, they will err on the side of printing more money. As the money supply goes up, there are more dollars around to be invested, which causes risk assets to go up.

This protracted period of financial repression is likely to go on for the better part of the decade. Interest rates will remain relatively low, and what we are seeing now is a transfer of wealth that accrues to borrowers, essentially at the cost of savers. So, what looks attractive is any play on a hard asset that can be levered with permanent financing, so you don't get shaken out in a margin call or a market selloff.

What's an example?

Housing is really attractive, given its affordability and fundamentals. We could see home-price appreciation of 8% to 10% a year for the next three to four years. And given that we have subsidized borrowing costs from the government, it is a transaction that can be highly levered at a great rate. We also are going to see a lot more leveraged buyouts that target companies, and that will help lift equity prices. Targeting companies that have stable cash flow and large cash balances is probably the place to be. Two places, in particular, that I like in the U.S. equity market are banks and financials, which are very, very cheap. They'll probably double in the next five years. I also like technology stocks. Many tech companies are loaded with cash. Their valuations are cheap, and they'll probably be the targets of leveraged buyouts over time.

What about investment opportunities overseas?

Given the current weakness, people should be buying gradually into the BRICs [Brazil, Russia, India, and China] over time. But the MIPS -- Malaysia, Indonesia, the Philippines, and Singapore -- are at the point on the growth curve where the BRICs were more than a decade ago. We could easily see a price appreciation for the MIPS over the next decade of 300% to 400%, which should handily outperform the BRICs. The other thing that is more interesting than the BRICs are the frontier markets. When the Fed began buying assets, the first things that participated were the high-quality assets like Treasuries, along with high-quality stocks and bonds. As those assets were bid up, high-yield bonds and other assets began to appreciate. The frontier markets sat at the end of the global food chain in terms of benefiting from monetary easing.I expect them, over the next three to five years, to outperform the BRICs and the developed markets.

Why are you so concerned about Japan?

By expanding its balance sheet, Japan is moving into a risk territory that we have never seen. By the time Japanese Prime Minister Shinzo Abe's two-year plan is finished, the Bank of Japan's assets should represent about 60% of GDP. So if Abe is successful, inflation will increase by three percentage points from minus-1% to plus-2%, and bond yields in Japan, which are among the world's highest in real-return terms, at 50 basis points, or 0.50%, could rise in line with inflation. So you could get bond yields of up to 3½%. But the government of Japan's annual interest on its debt would exceed its total tax receipts at 3½%, because the debt-to-GDP ratio would be around 230%.

The central bank would have acquired all of these JGBs (Japanese government bonds) at low interest rates. But if it decides that it must contract the money supply and sell assets, how does it do that? It has no capital, because the value of its assets is less than the value of the liabilities, including its currency. Depreciating currency and rising interest rates won't create a very attractive destination for foreign capital. Without foreign capital and with a domestic savings rate that will be negative by that time, it will be very difficult for Japan to find buyers for its government bonds. The central bank could find it very difficult to stop the rise of inflation -- a really scary scenario.